Professional Services – The first few stages of growth…

I was on a panel last night at a MoDevDC event (this Meetup is a group of amazing DC Metro entrepreneurs focused on the mobile applications space).  Many of the people in the audience were either on contracts as 1099 consultants or they were building mobile applications with the hope of building a sustainable company.   A topic came up during the panel about the different stages of growth an entrepreneur can expect as they grow their business.   I raised the point that the stages of growth are different for a services business than they are for a software business.  I also raised the point that running a company with both product and services can be complex as well.

There is a ton out there on the stages of growth a product entrepreneur goes through—just read one of the following and you will find all you will need:

If you are building a Product + Services company there is also a great book by the 37 Signals team called “Rework”.  However, if you are a one person shop and thinking about building a professional services technology consulting business I found that there is very little for a startup founder to read so I thought I would detail just a few thoughts below from the panel discussion on those stages.  Hopefully we can build on this as time goes on…

So here goes…

The Indie Stage…
You are en extremely talented programmer… company’s hire you on a 1099 basis to get the job done in a high quality way…   they pay you a high rate for your talents… you are a mercenary of sorts.

Your income could be in the range of $150k to $200 US depending on your rate and the number of hours you work (your utilization).  For example, if you bill $125 an hour and work the standard 1410 hours per year you can make ~$176,250 a year before taxes.  Not bad.  (Calculated as: 260 work days (52 weeks in a year * 5), minus 10 days unpaid vacation, 5 unpaid sick days and 10 unpaid holidays that leaves roughly 235 maximum billable days and hopefully you will never be under 75% utilized for a minimum of 176.25 billable days or 1410 billable hours.  At an average bill rate of $125 per hour one person is $176,250 in revenue.)

Your overhead is also minimal.   Get an LLC or S-Corp setup– Use a company like Legal Zoom to easily set it all up for a low cost…. Open a company bank account (Ensure they do ACH transactions)–  PNC has a great program for small businesses however a local bank may be a better choice once you start needing a line of credit.   Get your own domain and invest your time in free tools such as Google Apps

The dip your toe in stage…
The next stage many Indie services professionals go through is expanding their current contracts by hiring other 1099’s for $75/hr and billing them out at $125+/hr.

  • Income

You: ~$176,250
Adding additional people to projects:

revenue  =  $176,250

cost at $75/hr * 1410 hours/yr = $105,750

Net $70,500 per

  • Overhead (Your goal at this stage is to keep overhead as low as possible and work out of your homes and coffee shops)

Trademark the company name
Start investing in tools such as Basecamp
Get a good part time Quickbooks accountant ($500/month)
Invest in a SaaS Time Keeping system that integrates into Quickbooks
Get a good lawyer with standard professional services contracts
Allocate some weekend time to:

Build your bid / scoping methodology

Understanding the P&L – and are great resources

Building some marketing decks & PDFs that outline your company’s capabilities, case studies and differentiators


The Management & Overhead Stage (A giant leap of faith)
So you worked your tail off and billed 100% of your time last year while still somehow hiring  5 1099’s and put $250,000+ ($70,500*5 minus taxes and hiccups) in the bank and you want to use that to scale.   This will by far be one of the hardest stages to get your new company through… It’s called the “Management” Stage because most of your work will require a lot of YOUR great managerial skills and a little leadership.    It’s call the “Overhead” Stage because this is the stage where you will have to invest money to make money—as well as take on personal risk (Line of Credit).

  • Obviously this is a stage where Profit and Loss management are key….   Get to know the “70, 20, 10 Rule”.  Your P&L should always balance out to a 70% maximum Cost of Goods Sold, a 20% maximum overhead and a 10% minimum profitability.
  • This is the stage when you go from billing yourself out to managing a team full time (you are overhead!)
  • This is the stage where you can begin to craft the company’s values (hint: Integrity must be at the top for a professional services firm—it better be true or you are in the wrong business).  You should also take a stab at a company Vision, Mission, Goals, and Objectives & Strategy.
  • This is the stage where you turn your 1099’s into W2s… (There are laws)
  • At this stage YOU are the sales person.   This is the stage where you have to determine what type of customer you want—not all customers are good customers… What size of deal is sustainable?  What is a good project?   It can’t cost you three months of sales calls and a week’s worth of someone’s time writing an RFP response to get a $25k gig.
  • This is the stage where YOU have to build out and document all of your companies Quality Assurance, Design, Project Management processes and methodologies—Why? –because you will be producing a low grade product inefficiently without them, and your customers are going to ask to see them…
  • Income

10 people is $1,762,500 in revenue

260 work days (52 weeks in a year * 5)
Minus 10 days paid vacation
Minus 5 sick days
Minus 10 federal holidays

235 billable days at 75% utilization = 176.25 billable days or 1410 billable hours
At an average bill rate of $125 per hour one person is $176,250 in revenue

Cost of Goods (62.4%)

$1,100,000 – Your consultants probably get paid roughly $110,000 per year
Overhead ($400,800 or 22.7%)
$176,250 – You
$    2,000 – Insurance (Workman’s comp, Liability, Errors and Emissions)
$ 39,600 – Benefits ($300 per employee per month)

Consider starting a relationship with a PEO (Administaff or Trinet)

$  6,000 – Tools: Email, Highrise CRM, Unfuddle ($500/month all up)
$ 12,000 – Marketing ($1,000 per month)
$ 12,000 – Computers for your staff (12 * $1000 = $12,000 or ~$1,100 per month on a lease)
$  5,000 – Line of credit ($5,000 enrollment fees and a lot of personal liability)
$ 88,000- Payroll Expenses (Salary * .08)
$ 60,000 – Rent

Net: $261,650 (14.8%) — Wow, not much better than last year and it was a great deal harder… but this year is going to allow you to successfully scale for many years to come…

Grow the contracts… Grow the people… Increase the bank account… Increase your Line of Credit…  MAKE YOUR CUSTOMERS HAPPY!

The Stable Growth “Leadership” Stage

This is the stage where your revenues and net income allow you to invest in more overhead.   You begin to fill out an organization structure.   This stage is referred to as the “Leadership” stage because you will have to grow leaders that you empower to run major portions of your company.
This is the stage where you begin to offer “solutions” with prebuilt intellectual property (IP) so make sure you write your contracts in a way that you at minimum ‘share’ ownership in the IP.
I cannot write much more about this stage and those beyond that has not already been well documented in detail by David in the book at this link .

How tech companies behave depends on where they sit on a value chain

Lately I’ve been working with a number of small technology companies all of which have niche vertical solutions.  The common denominator across each of the companies is that they all are struggling with how they should behave in order to scale to the next level of growth.

As I work with each of these companies I’m going to document here the learning’s and try to find a framework that will provide others running similar companies value.

The framework I’m starting with is one of a value chain.   Here is how I am currently thinking about categorization and behavior in regards to where a company falls in the technology value chain.

Please let me know what you think…

In today’s world of Enterprise Computing motivation and behavior of companies is different depending on where they sit on the Value Chain?

Over the last 20 years I’ve had the opportunity to spend a great deal of time with many technology companies (Systems Integrators, ISV’s, OEM’s, Resellers, Training Providers and Hosting Providers) large and small and I’ve often wondered why many act as they do.

One way that has helped me to understand these motivations was to put companies on a value chain.

If chip manufacturers are on the bottom, right above the chips are the desktop and server hardware providers that use those chips… Right above the hardware providers you will find the platform providers like Microsoft with the operating system at the very bottom of that stack.

Then there is a hard line of demarcation on this value chain where IT value ends and business value begins.   Unfortunately, the traditional platform product vendors, not at all unlike “dial-tone” in the telecommunications industry, are on the IT value side of that equation.  Hence, most of their sales are targeted to the IT directors in the CIO’s office.

On that line demarcating where IT value ends and business value starts you will find IP that is built on, and requires, that platform dial-tone.   These are the typical “management” applications:

  • Supply Chain Management
  • Enterprise Content Management
  • Identity Management
  • Customer Relationship Management (CRM)
  • Enterprise Resource Planning and Management (ERP)
  • Document Management
  • Records Management
  • Knowledge Management
  • Asset Management
  • Forms Management
  • Systems Management

Platform providers typically don’t produce much IP in this area, but they enable other companies to build on their platform.

It is this very area where software as a services (SaaS) has had the largest impact.  Hosted CRM, ERP, Content Management and other services have become a reality and customers have re-evaluated the way they think about investing in technology.

Next on the value chain above the horizontal business rules are the vertical business rules.  These are applications that run companies/agencies/department/institutions business.   These vertical business rules are the solutions that customers invest in to solve their business problems.

The companies that sell at this level of the value chain have a deep understanding of the business problems as well as business process reengineering.  These companies are considered “Thought Leaders” and are companies such as Systems Integrators (examples: IBM Global Services, Northrop Grumman, Lockheed Martin and Accenture) and vertical ISVs (example: Curam Software).

Customers want to “partner” with companies at this level that understand their business problems and provide “solutions;” any company not fitting this profile is just another “vendor” selling commodities.   This can put the vendors below the vertical providers at a competitive disadvantage right from the beginning because some of the most important horizontal, platform and hardware decisions will be made by these vertical solution providers.

Companies may indeed sell across multiple levels of this value chain but where they are positioned on it depends on where they make the majority of their revenues.  For example, Microsoft still makes a majority of its revenues from Operating Systems and Office software.  They do have horizontal intellectual property (IP) such as CRM and ERP and they also have vertical software such as HealthVault but Microsoft is primarily a platform IP provider.

Cost of Sale

Another interesting element of the Enterprise Computing Value Chain is that the farther up the stack your company’s products are the more expense it takes to make a dollar.

Comparing IBM, Lockheed Martin, SAP and Microsoft you will see that IBM and Lockheed Martin both make a majority of their revenue from solutions consulting at the vertical IP level, SAP is primarily a horizontal IP company, and Microsoft is a platform provider.

IBM and Lockheed Martin are primarily people centric companies filled with thousands of consultants.   Microsoft on the other hand primarily has software developers building the next generation platform software  This if fundamentally why platform providers struggle–Microsoft’s customers would love to have them solve their business problems but their shareholders like the high profit margins and low expense.   To make the transition to a company that solves business problems they would have to increase their consulting force, deal with longer sales cycles, focus on areas such as business process re-engineering and build vertical IP such as 911 solutions for state government and student information management systems for schools.

You might say, revenue is revenue… but it’s not.   Just look at the valuation of a software company vs. a services company in the marketplace.  Services companies are valued at less than 1 times earnings where software companies are valued at 3 or more times earnings.   The magic of software has always been you can build it once and sell it many times (an exponential growth model), but in the consulting world the main way to grow revenue is to add more warm bodies to the company (a very linear growth model).

Horizontal IP is above the line…

An interesting aspect of Horizontal IP is that it is sold vertically.   Companies and government do not buy Identity Management or Customer Relationship Management (CRM) products per se.  They do however buy solutions that require Identity Management and/or Customer Relationship Management engines.   This is primarily why horizontal IP is a higher cost of sale (COS).   The COS is not however as high as a vertical IP provider–why, because the engine is reusable on other applications the customer made need the engine for and they don’t have to buy it over and over again.

Any account manager working for a company that has a CRM product will tell you that they don’t try to sell the value of the their CRM product to IT… They do however sell scenarios to government agencies for example to track bad guys, Army recruits, 311 calls and security clearances.   The underlying CRM engine is just a tracking workflow development environment that comes along with the configuration code that will be built to track that specific scenario.


There are many sources that say that for every dollar of software a customer buys they also spend greater than 10x that dollar in services.

The services spend per dollar of software equation increases the further up the value chain one goes…

With vertical IP there is business process reengineering (BPR) and possibly vertical application development to configure the solution specifically for the client.  There is also a need to implement some sort of “management” engine at the Horizontal IP level to support the Vertical IP.  Then there is also a need for updated databases, middleware, operating systems and hardware.   At all these levels there is a need for services.   Let’s take one of the earlier examples.  If an Intelligence agency were going to buy a solution to track security clearances they would need to hire people to understand the current process, make recommendations on the new process and train agencies on how to use the new solutions.  They would also have to develop the vertical application on top of any Horizontal IP CRM engine.   They would then have to hire people to install the Horizontal IP CRM engine.   If the CRM engine requires new databases, operating systems then people may have to be brought in at the platform IP level to consult there as well.

All in all, the premise is that the farther up the stack you go the more services that are required.

Management versus Leadership

I was helping a friend today work through some issues with his company and the topic of management versus leadership came up.   The subject made me think about a great discussion I had with an Army Colonel a few years back.  I have summarized my notes from that conversation below.

If Management is about systems, processes, policies and resources and Leadership is about vision, inspiration, values and people then the basic premise is that ‘Leaders deal with management shortfalls’.

Basically, leadership is required when the systems & process do not work…. Leadership is required when the policies are not applicable or do not exist… Leadership is required when there are not enough resources to accomplish the task…

So what do good managers do?

  • They match resources to taskings…
  • They measure, set goals and compare…
  • They are accountable…  Failure to hold people accountable will create a culture of mediocrity.
  • They organize around the product (mission) and not the processes (functions)…  Keeping in mind that organizational structure can—by itself—preclude success, but it cannot—by itself—ensure success.
  • They recognize that micro-information is not the same as micromanagement.  They are not afraid to engage the tough problems themselves.
  • They watch out for systems that tend to punish the excellent in order to reward the mediocre.

And… what do good leaders do?

  • They create more leaders–constantly doing leadership development by identifying potential leaders and mentoring / grooming them along…
  • They spend their time doing things only they can do for the organization…
  • They are principled, transparent and their values become institutional values…
  • Their character is built from the cross section of courage, integrity and perseverance…
  • They avoid issuing orders, preferring to request, imply, or make suggestions… They use storytelling to make points…
  • They ignore petty attacks and fight back when it is important enough to make a difference…
  • They are consistent…
  • They don’t lose confidence in their people when they fail…
  • They never stop learning…
  • They simplify…
  • They are positive and have fun…

Here are the books I recommended on the subject:

Feel free to add information on the subject as I’m sure he would be very appreciative as would others…